THE Court of Tax Appeals (CTA) has ruled that in determining whether an interest expense claimed as a deduction on gross income is paid to a related party, it is the number of shares of stock owned by the lender in the borrower corporation that will control, and not the amount of capital subscribed to.

In the case of Phil Foods Properties Inc. v. Commissioner of Internal Revenue, the CTA allowed as a deduction on the gross income the interest payments made by Phil Foods to Gardenia Bakeries (Phils.) Inc., which is one of Phil Foods’s stockholders. The CTA overturned the Bureau of Internal Revenue’s (BIR) finding and that the deduction of such interest payments to Gardenia should be disallowed because Phil Foods and Gardenia are related parties, thus, interest payments on loans between the two are not deductible as expenses in their business.

The BIR based its finding that Phil Foods and Gardenia are related parties on the amount of Gardenia’s subscribed capital in Phil Foods, which amounts to around P12 million, or 80 percent of the subscribed capital of Phil Foods.

Thus, the BIR concluded that interest payments made to Gardenia by Phil Foods should not be allowed as a deduction because Gardenia owns 80 percent of Phil Foods, and the two are thus, related parties because either of them has more than 50-percent ownership in the other.

For the interest payments to be deductible from the gross income as a business expense, the principal debt must be in connection with the business of the taxpayer claiming the deduction and was not for his personal use; theinterest expense must have been incurred during the taxable year, was legally due and must have been stipulated in writing; and the principal debt must not be between related taxpayers.

But the CTA said that in determining whether one corporation is related to another, it is the number of subscribed shares of each stockholder, regardless of their par values, that will control.

In this case, Gardenia only owns around 200,000 shares of Phil Foods, while the other 300,000 shares are owned by other persons and Gardenia only owns 40 percent of Phil Foods.

Thus, Gardenia and Phil Foods were not considered by the CTA as related parties, and the interest payments made by Phil Foods to Gardenia cannot be deducted as expenses from its gross income.

Dave Cagahastian is BusinessMirror's reporter covering the Office of the President and the Department of Labor and Employment. He has recently finished a law degree from the University of the Philippines, and holds a business degree from the International Academy of Business and Economics. In the past two years in a row, he had won the Sinag Financial Literacy Journalism Award sponsored by Sun Life Financial Philippines, getting the third place in 2014 then ‎the first prize in 2015.

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